Partners, Volume 13, Number 1, 2003

Earned Income Tax Credit: Maximizing the Benefit

By Jessica LeVeen

The
Earned Income Tax Credit (EITC) is one of the U.S. governments largest
and most effective anti-poverty policies. In 2000, 19 million people obtained
approximately $31 billion in EITCs, and each year the program lifts an
average of 5 million families above the poverty line. Unfortunately, some
individuals and families arent reaping the full benefit of the tax credit.
Government, business and community groups are working together to help
maximize the impact of EITC.

Qualifying for the EITC

Enacted by Congress in 1975, the EITC is a refundable tax credit that
reduces the tax burden on low- and moderate-income workers, particularly
those raising children. The credit not only reduces a workers income
taxes, but also any amount remaining beyond the tax liability is refunded
to the taxpayer.

Individuals and families are eligible to claim the EITC if their income
is less than twice the federal poverty limit. Both income and family size
determine the credit the taxpayer will receive. For example, in tax year
2002, a family with two or more children earning income up to $33,178
would be eligible for an EITC up to $4,400. Individuals with no children
would be eligible for a much lower EITC. The average EITC recipient this
year will earn a credit of $1,700.

Benefits and concerns

The benefits of the EITC are significant: not only does the tax credit
help reduce poverty, but it also offers an incentive to work. The EITC
has slowed the rising income inequality between the working poor and high-income
workers during the past decade. In addition, it can help low-income families
build assets.

Despite these benefits, not all eligible filers claim the EITC. A Government
Accounting Office study of 1999 data found that 86 percent of eligible
families with children claimed the EITC, but only 45 percent of workers
without children claimed the credit. The Internal Revenue Service (IRS)
is currently working to increase the participation rate of eligible EITC
filers.

Unfortunately, the benefits of the EITC to low-income workers are often
diminished by the use of paid tax preparers and refund anticipation loans
(RALs). A recent study by the Brookings Institution found that nationwide,
68 percent of EITC filers used a paid tax preparer. Tax preparation services
are often concentrated in low-income neighborhoods and heavily marketed
to low-income filers. EITC filers can pay $100 or more in fees for these
services.

In addition to costly tax preparation services, low-income taxpayers
are increasingly using RALs to obtain their refunds more quickly. Filers
using RALs receive an advance on their anticipated refund about 7 to 10
days more quickly than if they received refunds via direct deposit into
their bank accounts. Nationwide, 39 percent of EITC returns were claimed
using RALs. In some Sixth District communities, more than 60 percent of
EITC returns were filed with RALs.

The fees associated with RALs  $100 for the RAL and an average fee of
$100 for tax preparation  substantially reduce an EITC filers refund.
In 1999 an estimated $1.75 billion in EITC funds were diverted from low-income
workers to tax preparation services.

Coalitions increase EITC awareness

Broad-based coalitions have formed to increase the amount of the EITC
captured and retained by low-income workers. The IRS has partnered with
community organizations, financial institutions and local governments
to increase EITC awareness and to promote free tax preparation services.

The IRS and community partners promote this service through Volunteer
Income Tax Assistance (VITA) sites, where trained volunteers prepare federal
tax returns without charge. The sites provide an important alternative
to high-cost tax preparation services.

Some VITA sites offer additional services to promote financial stability,
including financial education, assistance in opening bank accounts and
asset-building tools such as Individual Development Accounts (IDAs). These
services not only enable low-income workers to maximize the benefit of
EITC, but also provide them with opportunities to improve their overall
economic well-being.

Spotlight
on New Orleans:
The Central City Asset-Building Coalition

New Orleans' Central City Asset-Building
Coalition recently initiated an EITC program focused on the
city's central area, identified by the Casey Foundation as
having one of the lowest EITC participation rates in the nation.

The partnership, which includes the
IRS, Tulane-Xavier National Center for the Urban Community,
Entergy Corporation and the Annie E. Casey Foundation, as
well as other nonprofit groups, has set up three permanent
sites and a mobile income tax preparation unit over the last
two years to help low-income clients with their taxes.

Clients are referred to Hibernia National
Bank for free checking accounts and are encouraged to enroll
in financial education classes taught by Consumer Credit Counseling
Services and Neighborhood Housing Services of New Orleans.
Eligible clients are also referred to the Individual Development
Account (IDA) Collaborative of Louisiana to participate in
an asset-building IDA program.

Last year the centers helped prepare
249 tax returns that saved participants a total of $64,750.
By taking a comprehensive approach to improving EITC participation,
the coalition has contributed significantly to long-term strategies
to alleviate poverty.